What Are Bond Ratings? Definition, Effects, and Agencies (2024)

What Is a Bond Rating?

A bond rating is a way to measure the creditworthiness of a bond, which corresponds to the cost of borrowing for an issuer. These ratings typically assign a letter grade to bonds that indicate their credit quality. Private independent rating services such as Standard & Poor's, Moody’s Investors Service, and Fitch Ratings Inc. evaluate a bond issuer's financial strength, or its ability to pay a bond's principal and interest, in a timely fashion.

Key Takeaways

  • A bond rating is a letter-based credit scoring scheme used to judge the quality and creditworthiness of a bond.
  • Investment grade bonds are assigned “AAA” to “BBB-" ratings from Standard & Poor's and Fitch, and "Aaa" to "Baa3" ratings from Moody’s. Junk bonds have lower ratings.
  • The higher a bond's rating, the lower the interest rate it will carry, due to the lower risk, all else equal.
  • The bond rating agencies rate all types of bonds, from corporate bonds to sovereign bonds.

Understanding Bond Ratings

Most bonds carry ratings provided by at least one of the following three chief independent rating agencies:

  1. Moody's Investors Service
  2. Fitch Ratings Inc.

To determine a bond's rating, these agencies conduct a thorough financial analysis of a bond's issuing body, whether they are U.S. Treasuries or bonds from international corporations.

Based on each agency’s individual set of criteria, analysts determine the entity’s ability to pay their bills and remain liquid, while also taking into consideration a bond's future expectations and outlook. The agencies then declare a bond's overall rating, based on the collection of these data points.

Pricing, Yield, and a Reflection of Long-Term Outlook

Bond ratings are vital to alerting investors to the quality and stability of the bond in question. These ratings consequently greatly influence interest rates, investment appetite, and bond pricing.

Higher-rated bonds, known as investment-grade bonds, are viewed as safer and more stable investments. Such offerings are tied to publicly traded corporations and government entities that boast positive outlooks.

Investment grade bonds contain “AAA” to “BBB-" ratings from Standard and Poor's and Fitch, and "Aaa" to "Baa3" ratings from Moody’s. Investment-grade bonds usually see bond yields increase as ratings decrease. U.S. Treasury bonds are the most common AAA-rated bond securities.

Non-investment grade bonds (junk bonds) usually carry ratings of “BB+” to “D” for Standard and Poor's and Fitch, and "Baa1" to "C" for Moody’s. In some cases, bonds of this nature are given “not rated” status. Although bonds carrying these ratings are deemed to be higher-risk investments, they nevertheless attract certain investors who are drawn to the high yields they offer. Some junk bonds are saddled with liquidity issues, however, and can feasibly default, leaving investors with nothing.

In Aug. 2023, Fitch Ratings downgraded the long-term ratings of the United States to "AA+" from "AAA" due to the anticipated fiscal deterioration over the next three years, increasing government debt burden, and the erosion of governance related to "AA" and "AAA" rated peers over the last two decades that has resulted in repeat debt limit standoffs and 11th-hour resolutions.

Role of the Rating Agencies in the 2008 Financial Crisis

Many Wall Street watchers believe that the independent bond rating agencies played a pivotal role in contributing to the 2008 economic downturn. In fact, it came to light that during the lead-up to the crisis, rating agencies were bribed to provide falsely high bond ratings, thereby inflating their worth. One example of this fraudulent practice occurred in 2008 when Moody's downgraded 83% of $869 billion in mortgage-backed securities, which were given a rating of "AAA" just the year before.

In short: long-term investors should carry the majority of their bond exposure in more reliable, income-producing bonds that carry investment-grade bond ratings. Speculators and distressed investors who make a living off of high-risk, high-reward opportunities, should consider turning to non-investment grade bonds.

Why Do Bonds With Lower Ratings Have Higher Yields?

Bonds with lower ratings have a greater risk of default than bonds with higher ratings. These bonds tend to have higher yields so as to still be able to entice investors, despite bringing greater risk.

What Is a Junk Bond?

Bonds that are non-investment grade are considered to be high-yield or "junk" bonds. They are considered to be high-risk and usually have ratings of "BB+" to "D" or not rated. Investors can profit through buying junk bonds, but they also are at greater risk of losing their investment, as these kinds of companies tend to have liquidity issues.

What Is an Investment Grade Bond?

An investment-grade bond is a so-called high-quality or low-risk bond. It is considered to be a fairly safe bet and has a very low rate of default. Bonds rated "AAA," "AA," "A," and "BBB" are considered investment grade.

The Bottom Line

A bond rating is a grading given to a bond that indicates its creditworthiness. Bond ratings are assigned by agencies, such as Moody's, Standard & Poor's, and Fitch Ratings, and reflect an analysis of the bond issuer's financial strength or capacity to pay a bond's principal and interest.

The rating organizations assign grades to the bond, such as "AAA," which indicates lower risk, or "B-," which indicates greater risk. Higher-risk bonds offer higher yields, while lower-risk bonds offer lower yields.

What Are Bond Ratings? Definition, Effects, and Agencies (2024)

FAQs

What Are Bond Ratings? Definition, Effects, and Agencies? ›

A bond rating is a grading given to a bond that indicates its creditworthiness. Bond ratings are assigned by agencies, such as Moody's, Standard & Poor's, and Fitch Ratings, and reflect an analysis of the bond issuer's financial strength or capacity to pay a bond's principal and interest.

What is a bond rating quizlet? ›

bond rating is indicator of default risk, so the rating has a direct, measurable influence on the bond's interest rate and firm's cost of borrowing.

What do the bond ratings mean? ›

What does bond rating mean? A bond rating is a grade given to bonds that indicates their credit quality. Independent rating services such as Standard & Poor's and Moody's provide these evaluations of a bond issuer's financial strength, or its ability to pay a bond's principal and interest in a timely fashion.

What are the ratings agencies for bonds? ›

There are 3 main ratings agencies that evaluate the creditworthiness of bonds: Moody's, Standard & Poor's, and Fitch.

What is the bond rating affected by? ›

Credit risk

In general, the higher the credit rating, the agency considers the issuer more likely to meet its payment obligations. If an issuer's rating goes up, the price of its bonds will rise. If the rating goes down, the price will drop. An issuer's credit rating can change over time.

How does a bond's rating affect its price? ›

The ratings signal to investors the agency's view of the issuer's ability to pay the interest and principal when due. If a bond's credit rating is downgraded, the bond becomes less attractive to investors and its price will likely fall. The age of a bond relative to its maturity date can affect pricing.

What are the bond ratings for the United States? ›

AgencyRatingOutlook
S&PAA+Stable
DBRSAAAStable
S&PAA+Negative
Moody'sAaaNegative
10 more rows

What is the definition of a bond? ›

an amount of money that an organization or government borrows and promises to pay back on an agreed date with an agreed amount of interest, or the document that contains this agreement: a 10-year/20-year, etc.

Who pays for bond ratings? ›

Bond issuers pay the agencies for the service of providing ratings, and no one wants to pay for a low rating.

Can bond ratings be trusted? ›

Rating agencies play an integral role in both primary and secondary bond markets. While the rating agencies provide a valuable service, the accuracy of such ratings came into question after the 2008 financial crisis. 1 The agencies are often criticized when dramatic downgrades come very quickly.

What do rating agencies do? ›

Rating agencies assess the credit risk of specific debt securities and the borrowing entities. In the bond market, a rating agency provides an independent evaluation of the creditworthiness of debt securities issued by governments and corporations.

Who regulates the rating agencies? ›

U.S. Securities and Exchange Commission.

What are the Big Three bond rating agencies? ›

These are assigned by credit rating agencies such as Moody's, Standard & Poor's, and Fitch, which publish code designations (such as AAA, B, CC) to express their assessment of the risk quality of a bond.

What do bond ratings mean? ›

A bond rating is a letter-based credit scoring scheme used to judge the quality and creditworthiness of a bond. Investment grade bonds are assigned “AAA” to “BBB-" ratings from Standard & Poor's and Fitch, and "Aaa" to "Baa3" ratings from Moody's. Junk bonds have lower ratings.

What factors do rating agencies look at when issuing bond ratings? ›

Credit ratings assigned by rating services provide a bond's quality and riskiness. Rating agencies use several metrics in determining their rating score for a particular issuer's bonds. A firm's balance sheet, profit outlook, competition, and macroeconomic factors determine a credit rating.

Why are bond ratings important in assessing risk? ›

Bond ratings provide investors with a quick and standardized way to evaluate the credit risk of a bond issuer. Higher-rated bonds are generally considered lower risk while lower-rated bonds are viewed as higher risk. Investors can use these ratings to assess the likelihood of the issuer meeting its debt obligations.

What a bond rating tells you about a bond? ›

The higher a bond's rating, the lower the interest rate it will carry, due to the lower risk, all else equal. The bond rating agencies rate all types of bonds, from corporate bonds to sovereign bonds.

Which bond has the highest rating? ›

AAA bonds are the highest rated corporate bonds available in India.

Which bond ratings are high risk? ›

Obligations rated Ba are judged to have speculative elements and are subject to substantial credit risk. Obligations rated B are considered speculative and are subject to high credit risk.

What is the best rating a bond can receive *? ›

The highest credit rating that a bond can receive is AAA. This means that the issuer of the bond, which can be a corporate entity or a governmental organization, is very creditworthy and is highly likely to repay the bond on time and in full.

References

Top Articles
Latest Posts
Article information

Author: Stevie Stamm

Last Updated:

Views: 5425

Rating: 5 / 5 (60 voted)

Reviews: 83% of readers found this page helpful

Author information

Name: Stevie Stamm

Birthday: 1996-06-22

Address: Apt. 419 4200 Sipes Estate, East Delmerview, WY 05617

Phone: +342332224300

Job: Future Advertising Analyst

Hobby: Leather crafting, Puzzles, Leather crafting, scrapbook, Urban exploration, Cabaret, Skateboarding

Introduction: My name is Stevie Stamm, I am a colorful, sparkling, splendid, vast, open, hilarious, tender person who loves writing and wants to share my knowledge and understanding with you.